S&L Relic Is Sword of Choice in U.S. Bid to Punish Banks

“Every U.S. attorney has to think about ways to use statutes that are already there as we don’t have the ability to pass laws,” said Preet Bharara, U.S. attorney for the Southern District of New York. Photographer: Peter Foley/Bloomberg

Sept. 24 (Bloomberg) -- Weeks after taking over as the U.S.
Attorney in Manhattan in 2009, Preet Bharara said he considered
whether his office could hold individuals and banks liable for
the financial crisis when there wasn’t enough evidence to bring
a criminal case.

During an interview in his office overlooking the
Brooklyn Bridge, Bharara recalled that he came upon an idea
after long talks with staffers: maybe lawyers in the office’s
civil division could go after these cases. After months of
research, prosecutors dusted off the Financial Institution
Reform, Recovery and Enforcement Act of 1989, known as FIRREA.

The law, a relic of the savings-and-loan crisis of the
1980s, allows the government to sue an individual or group,
rather than charge them with a crime, for fraud that affects a
federally-insured financial institution. FIRREA carries a 10-year statute of limitations, giving the government double the
time to bring its case than allowed under other securities laws.

In the two decades following the S&L crisis, the law was
used sparingly. Now, because of the push by Bharara’s office, it
has become the weapon of choice for federal prosecutors
investigating the root causes of the financial crisis that
started in 2008.

Since 2010, prosecutors in the Southern District of New
York have used the statute at least six times, not just against
individuals accused of defrauding a bank, but against banks
alleged to have defrauded third parties. In the interview,
Bharara talked about FIRREA while declining to discuss pending
cases and matters.

Trial Starts

One case, in which the U.S. claims Bank of America Corp.’s
Countrywide unit defrauded Fannie Mae and Freddie Mac by selling
them billions of dollars in bad mortgages, is scheduled to go to
trial today with jury selection and opening statements before
U.S. District Judge Jed Rakoff in Manhattan.

Using FIRREA, the U.S. Attorney in Los Angeles sued McGraw-Hill Cos. and its Standard and Poor’s unit in February, alleging
the companies knowingly understated the credit risks of bonds
and derivatives.

JPMorgan Chase & Co. disclosed last month that the U.S.
Attorney in Sacramento, California, had opened civil and
criminal inquiries into mortgage-backed securities transactions
initiated by the bank from 2005 to 2007.

The case is a FIRREA prosecution, according to a lawyer
briefed on the matter who asked not to be identified because the
matter is confidential. Charges related to the sales could be
filed as early as today, another person familiar with the matter
said.

Brian Marchiony, a spokesman for New York-based JPMorgan,
declined to comment on the probe.

Springsteen Photographs

“I am proud that other people around the country have seen
that success and realized this is a tool,” Bharara, 44, said in
the Sept. 10 interview at his office, which is lined with
photographs of him with President Barack Obama, Vice President
Joseph Biden and Bruce Springsteen posing with Bharara’s mother
and one of his children after a concert. “You don’t have to
reinvent the wheel, you have to look and see what’s successful
elsewhere.”

In addition to FIRREA, Bharara’s team has taken another
civil statute, the False Claims Act, or FCA, and repurposed it
as a weapon against the alleged perpetrators of the financial
crisis. The FCA, which was created during the Civil War to
combat fraud against the Union Army, is now aimed at any attempt
to defraud the federal government.

Separate Investigations

The statutes have advantages. Both demand a lower burden of
proof than what is needed to win a criminal case. While trying
to build FIRREA cases, prosecutors also are allowed access to
secret grand-jury evidence developed in the course of separate
criminal investigations.

The U.S. can extract hefty penalties as well. The FCA has a
provision that allows the U.S. to collect three times the amount
of damages suffered by the government. FIRREA allows penalties
of more than $1 million for each fraudulent statement or act,
and as much as $5 million for continuing violations of
underlying criminal statutes.

Since March 2010, Bharara’s office has used the FCA and
FIRREA statutes to obtain mortgage fraud recoveries of almost
$500 million from CitiMortgage, Deutsche Bank AG and Flagstar
Bancorp Inc.

Such latitude, and the resurgence of the use of FIRREA, has
caused some in the legal community to sound the alarm. An August
2012 article in The Banking Journal warned the government’s use
of FIRREA posed a “devastating” threat.

Sticking Point

“Banks and those affiliated with banks should take these
lawsuits as seriously as a criminal grand jury subpoena,” Jay
Williams, Valarie Hays and Mir Ali, of Schiff Hardin LLP, wrote.

Four years ago, no federal prosecutor had yet applied the
FIRREA statute to a fraud that a bank or a financial institution
had itself engaged in.

“A plain reading of the statute as we discussed it
internally was, ‘Of course it affects the financial
institution,’” Bharara said. “And we were pretty heartened
that a few years on, two prominent, well-respected and smart
judges have strongly endorsed that plain-meaning interpretation
of the statute. And we expect more will.”

U.S. District Judge Lewis Kaplan in April upheld the
government’s theory in its foreign-exchange case against Bank of
New York Mellon Corp. In August, Rakoff rejected a bid to
dismiss a suit filed by Bharara’s office and ruled that Bank of
America, based in Charlotte, North Carolina, and its Countrywide
unit would have to go to trial in a $1 billion suit that alleged
they sold thousands of defective loans to Fannie Mae and Freddie
Mac, two home-mortgage finance companies now under government
control.

Alleged Fraud

When BNY Mellon contended that the affected institution
must be the victim or an innocent bystander to the alleged
fraud, not the perpetrator, Kaplan disagreed.

“As alleged here, a federally insured institution has
engaged in fraudulent activity and harmed itself in the process,
it is entirely consistent with the text and purposes of the
statute to hold the institution liable for its conduct,” Kaplan
said in a ruling that he called a legal “first.”

Bharara also made staff changes. While the office had a
civil division whose attorneys represented the government’s
interests in lawsuits and defended the U.S. in civil cases, he
created a Civil Frauds unit in March 2010 that combats large-scale financial fraud against the government.

Not Outmatched

The unit has filed more than two dozen lawsuits and
recovered almost $700 million in cases that include
pharmaceutical companies and health care and grant fraud.

“We may be outnumbered and outspent but I don’t think
we’re outmatched,” he said.

The office has also reached out to lawyers who specialize
in bringing whistle-blower suits, Bharara said. Under the FCA,
which was passed by Congress in 1863, citizens file so-called
qui tam cases that remain sealed from public view as the U.S.
Justice Department investigates the claims. The U.S. then
decides whether to join the suit. Bharara’s office joined the
Countrywide suit as a plaintiff.

“We’ve said, ‘If you’re thinking about places where
whistle-blowers can bring suit, one of those places should be
the Southern District of New York,’” he said.

Bharara said a fraud suit can be as effective as an
indictment in revealing bad behavior to the public.

Good Job

Some lawyers said FIRREA’s newfound popularity is due in
part to attempts by prosecutors to continue filing financial
crisis cases more than five years after the collapse of Lehman
Brothers Holdings Inc. in September 2008, at a time when a
criminal case is no longer feasible.

“Financial institutions are concerned that the government
may increasingly use FIRREA as a way to resurrect and invigorate
stalled investigations concerning the financial crisis because
of the 10-year statute of limitations,” said Keith Miller, who
is chairman of the securities enforcement practice at Perkins
Coie LLP in New York.

As these FIRREA cases go to trial, the defense bar may have
to adjust to a new timeline for prosecutors to build their case.

“Every U.S. attorney has to think about ways to use
statutes that are already there as we don’t have the ability to
pass laws,” Bharara said. “We have to use the tools we already
have -- some of them are pretty powerful and some of them go
unused.”

“If you end up bringing a suit where you detail a
narrative of bad conduct over time -- whether it’s a financial
institution or a toy company -- that’s one of the best services
we can provide,” Bharara said.

The case is U.S. v. Countrywide Financial Corp., 12-cv-01422, U.S. District Court, Southern District of New York
(Manhattan).